Moreover, you may need a different form of organization at different times in the life of your business. So don't be afraid to change your form of business if your needs change.
This article discusses the following four topics:
- The Big Picture (profits & losses, federal & state taxation)
- Forms of Business (the six business organizations for federal tax purposes)
- Tax Factors (the taxation of profits and losses)
- Business & Legal Factors (number of shareholders, raising capital, cash-flow issues, limited liability, ease of incorporation)
This article does not discuss various state-specific issues or the forms, documents, and process for incorporating your business.
The Big PictureThe decision about which form of business is best for you depends on a lot of factors. Primarily I will discuss the tax-implications of various forms of business. Probably the most important thing you need to think about right now is whether your business is going to be profitable over the long-term.
Hopefully your business will be profitable over the long run. But new businesses often encounter several years of losses before the business starts to be profitable. The biggest question you need to ask yourself is how you want to handle your business losses, and how you want to handle your business profits. This article assumes that your business is already profitable, or will become profitable in the near future. Deciding on a form of organization when your business is losing money is discussed in a separate article.
All of the forms of business organizations can be separated into two groups: corporations where tax is assessed at the corporate level and "pass-through entities" where tax is assessed at the shareholder level. The phrase "pass-through entity" means that profits are not taxed to corporation. Instead, 100% of profits (or losses) are distributed (or passed-through) to the shareholders. Each shareholder reports his or her share of profits or losses on his or her individual Form 1040.
Here's the breakdown of the various types of organizations.
Taxed at the corporate level:
- LLCs taxed as corporations, and
- Non-profit organizations
Taxed at the shareholder level ("Pass-through entities"):
- Schedule C sole proprietors,
- Partnerships, and
- LLC/LLP/PLLC/PLLP taxed as partnerships